CRA jettisons the concept of safe income on hand and revises positions on computing safe income

In a presentation regarding its forthcoming paper on s. 55(2) and safe income, CRA indicated that it is no longer applying the concept of safe income “on hand.” Thus, in CRA’s view, while the “fundamental question is still the same”, there should no longer be the two-stage inquiry dictated by the Federal Court of Appeal in Kruco, namely, that income of the corporation as modified by s. 55(5) is first computed, and then the amount of that income that is still “on hand” is determined by looking at cash outflows following the computation. Instead, there will now be a single-stage inquiry as to how much of the corporation’s income as so computed contributed to the gain on the shares.

Also, contrary to Kruco and CRA’s previous acceptance thereof, CRA now considers that phantom income does not contribute to a capital gain on shares.

Given the significant departure from well-established administrative positions and the pending detailed position paper, such pronouncements will presumably apply prospectively (as with previous changes in position regarding Kruco) to avoid negatively impacting taxpayers that relied on such positions in planning their affairs. One might add that, in light of the lack of significant changes in the wording of s. 55(2.1)(c) from that applied in Kruco, Kruco is likely still good law unless the Court of Appeal subsequently determines that it was “manifestly wrong” (see Chen).

Further CRA comments included:

• In a change from its previous position that all contingent liabilities and reserves reduce safe income. CRA now considers that contingent liabilities or reserves reduce safe income only if they reduce or have the potential to reduce the income of the corporation on their materialization, so that there is no immediate effect on safe income if they are capital in nature.
• Rather than refundable taxes only being included in income when received, CRA now considers that the portion of refundable taxes that will be reimbursed due to a payment of a dividend before the end of the taxation year will be considered to be a reduction of such taxes paid or accrued (so that the potential safe income is reduced only by the net amount).
• When a corporation realizes the accrued gain, on a property that it had acquired on a rollover basis in consideration for preferred shares, on disposing of that property, that gain is now considered to contribute to the gain on those preferred shares, so that such gain is to be included in the safe income of the preferred shares.
• In situations where Holdco wholly owns a distributing corporation (Opco) and assets of Opco are spun-out to a transferee corporation (Newco) that is also owned by Holdco, the general formula for the split of the direct safe income (DSI) between Holdco and Newco is as follows:
  • DSI on the shares of Newco: DSI of Opco prior to reorganization X net cost amount of the assets transferred to Newco / total net cost amount of the assets of Opco prior to the reorganization
  • DSI on the shares of Opco after the reorganization: DSI of Opco prior to the reorganization X net cost amount of the assets retained by Opco / total net cost amount of the assets of Opco prior to the reorganization
• In a one-wing split-up butterfly wherein a portion of the assets of a corporation (DC) owned by Holdco1 and Holdco2 is spun-off to Holdco2, there could be a resulting misalignment of basis (including safe income that could be capitalized), so that Holdco1 could simply sell the shares of DC without any negative implications and Holdco2 could sell the assets it received with an increased ACB. However, where the reorganization is a bona fide split-up between arm’s length persons, there is no requirement to allocate safe income based on the formula.
• CRA then provides detailed examples showing how safe income and ACB should be allocated where there is a transfer (or successive transfers) of property on a rollover basis between related corporations, so as to avoid a misalignment of basis including safe income that could be capitalized.
• For instance, CRA indicated that where there was a spin-off of ½ of the assets of Opco to Newco, entailing a transfer of ½ of the shares of Holdco’s shares of Opco to Newco, it might be necessary for less than ½ of the ACB of the shares of Holdco in Opco to be transferred to Newco.

Neal Armstrong. Summary of CRA Update on "S. 55(2) and Safe Income - Where Are We Now?" under s. 55(2.1)(c).